NQ Mobile’s 54% Plunge Rebuilds Muddy Waters Influence

NQ Mobile Inc. (NQ), a Chinese mobile
services provider, spent six years preparing to go public. It
took Muddy Waters LLC one hour to erase half of the company’s
market capitalization.

NQ Mobile tumbled more than 60 percent in a span of about
54 minutes on Oct. 24 after Carson Block, the Muddy Waters
founder whose short sales outside of China have borne little
fruit, said the company fabricated revenue and lied about its
cash. The Beijing-based company’s shares closed last week with a
two-day loss of 54 percent even as NQ Mobile said the assertions
were false.

Declines such as those that sent NQ Mobile shares from $23
to $10.63 last week used to be common for Block, a 37-year-old
lawyer who switched to investing after he moved to Beijing in
1997. Since leaving China a year ago, Block’s bearish research
on Singapore-based Olam International Ltd. (OLAM) and Boston-based
American Tower Corp. did far less damage. NQ Mobile led a 4.7
percent slump in the Bloomberg China-US Index of the most traded
Chinese stocks in the U.S. last week.

“It speaks to the credibility that Carson has built in the
marketplace over time by conducting very high-quality work in
prior reports,” Sahm Adrangi, who manages $250 million at New
York-based hedge fund Kerrisdale Capital Management LLC, said in
a phone interview on Oct. 25. “He has proven himself to be one
of the premier short sellers.”

‘Massive Fraud’

Block wrote in an Oct. 24 report that investors should sell
NQ Mobile, saying the company inflated revenue and
misrepresented cash balances. The short seller said in an
interview with Bloomberg Television on Oct. 25 that the company
will end up like Sino-Forest Corp., the Chinese plantation
company listed in Canada that filed for bankruptcy protection
last year after Muddy Waters claimed it exaggerated revenue.

NQ Mobile denied the allegations, holding a two-hour
conference call Oct. 25 with analysts and investors in which it
detailed its financial statements and answered questions about
Block’s accusations.

“We welcome any third party the opportunity to check the
company cash,” Matt Mathison, the vice president of capital
markets at NQ Mobile, said in the conference call. “The truth
and the facts are on our side.”

NQ Mobile, whose co-chief executive officer is Omar Khan, a
former Samsung Electronics Co. chief strategy officer, raised
its 2013 revenue estimate to as much as $188 million on Aug. 12
from the upper limit of its prior forecast of $184 million.

‘Very Seriously’

“We believe it is a zero,” Block wrote in his report.
“At least 72 percent of NQ’s purported 2012 China security
revenue is fictitious.”

NQ said it will set up an independent committee that will
review Muddy Waters’ allegations, according to a PRNewswire
statement on Oct. 25.

“We take all of these allegations very seriously. They are
all completely false,” Khan said in a phone interview with
Bloomberg TV on Oct. 25. “We are a very transparent company. We
have had two independent investment banks validate our cash
balances.”

Analysts at Topeka Capital Markets and Piper Jaffray Cos.
have reiterated their bullish recommendations on NQ Mobile.
Topeka’s Frederick Ziegel kept his buy rating and $33.50 price
estimate on the stock after the Oct. 25 conference call, while
Piper’s Mark Murphy maintained an overweight rating and $27
price target. The average of four analysts’ share-price
projections compiled by Bloomberg is $28.88, or 172 percent
above last week’s close.

Short Interest

Henry Lin, the co-CEO, started NQ Mobile in 2005 with
$15,000 he and a high-school classmate cobbled together,
Bloomberg Businessweek reported in its Aug. 12 issue. He scored
investments from Sequoia Capital, Qualcomm Inc. and Fidelity en
route to an $89 million initial public offering in 2011. To
expand the company outside China, he recruited Khan, who had
just joined Citigroup Inc. to run the bank’s worldwide mobile
business.

Short sellers have increased bets against NQ Mobile to a
one-year high over the past three months. Bearish wagers on the
stock rose to 25 percent of shares outstanding on Oct. 23, the
day before Block’s report was made public, from 8.6 percent in
July, according to data compiled by Bloomberg and Markit, a
London-based research firm.

Bearish Contracts

The average short interest for the Standard & Poor’s 500
Index is 2.3 percent and the stock would be the second-most
shorted in the benchmark gauge for American equities if it were
a member, the data show.

Ownership of put options to sell NQ Mobile shares soared to
a record 105,194 on Oct. 23. That’s 34 percent more than the
number of calls to buy, according to open interest data compiled
by Bloomberg. Almost 17,000 bearish contracts traded on average
each day in the five days before the report was released, more
than 12 times the daily mean this year.

The China-US Index posted the biggest weekly decline in 17
months on speculation gains that sent the measure to a two-year
high were overdone. The Shanghai Composite Index was little
changed at 2,133.87 today.

Chinese Politburo member Yu Zhengsheng said over the
weekend that reforms to be discussed at a meeting next month
will be unprecedented, adding to signs that leaders are resolved
to push through far-reaching policy changes. Premier Li Keqiang
has pledged to cut the state’s role in the economy, change the
financial and fiscal systems, and overhaul land and household
registration rules to sustain growth in the world’s second-biggest economy.

‘Red Flag’

NQ Mobile is at least Block’s 10th target after he began to
publish his research in June 2010. Block gained fame for his
short-selling calls in Asia after regulators halted trading in
four of the first five companies he wrote about. Hedge fund
manager John Paulson sold his Sino-Forest stake at a loss after
Block said the company overstated its plantation assets.

“We have seen companies defraud auditors numerous times in
China with forged bank statements,” Block said in the Bloomberg
Television interview. NQ Mobile “cited certain companies
elsewhere in China that had all-cash at Level 2,” but that is
not the case, Block said. “This is a major red flag.”

Track Record

Investors in American Tower, the Boston-based operator of
cell-phone antennas, were unshaken by Block’s claims on July 17
that the company is worth less than its share price, and the
stock has gained 8.2 percent since the report.

New Oriental has soared 85 percent after Block said the
financial statements of the education services provider’s units
are fraudulent. Olam’s shares have dropped 11 percent since
Block said he was betting against the agricultural commodity
trader on Nov. 19, 2012.

Their “track record is spotty, but it definitely had an
impact,” David Semple, who manages international equity
investments at the Van Eck Emerging Markets Fund in New York,
said by phone on Oct. 25.

Muddy Waters said Tianjin Yidatong, NQ Mobile’s largest
trade debtor, is controlled by NQ Mobile and not an independent
company. NQ Mobile’s market share in China is about 1.5 percent,
not the 55 percent it reports, Block wrote. The company’s paying
user base in China is fewer than 250,000, versus the 6 million
it claims, he said.

Oppenheimer & Co. reduced its recommendation on the shares
to the equivalent of neutral from buy and removed its price
estimate, according to a report on Oct. 25.

“While many of the allegations raised were not new, the
report did provide some anecdotal evidence supporting these
allegations,” Andy Yueng, an analyst at Oppenheimer, wrote in
the report. “The controversy is likely to remain an overhang on
NQ in the near term.”